Wednesday, October 08, 2008

Comrade Greenspan's Five Year Plan

Some of the damage from the housing bubble is obvious. People are
getting kicked out of their homes, banks are going broke, and the
damage to the financial system is bleeding all over the
economy as otherwise sound firms, and even state governments, can't
get credit.

But that's not the damage that would be obvious to someone who
dropped down from Mars. The Martian would see a different kind of
damage. For some unaccountable reason, at a moment where the
apparently sapient species that dominates this planet is starting, in
places (like Beijing), to literally choke and burn on its own fumes,
that species chose to put an enormous amount of its aggregate
resources not into new technology to deal with the problems, but
instead, into building new suburbs of Las Vegas.

The reason we did this, someone might explain to the Martian, is
that ultimately, it was investors who had control of these resources
who decided how to allocate them --- and new technology is perceived
as a risky investment, while housing was perceived as safe.

And yet, the safe investment is now the thing that's blowing up the
banks. Why?

Well, at some point just a few years ago, housing was safe.
Housing was safe mostly because there were a whole lot of safeguards
put into the market to prevent dangerous deals. You couldn't get a
mortgage to buy a house unless you demonstrated a serious ability to
pay, and put in a large down payment, to make sure you had some
skin in the game incase the deal went south. What happened in the
meantime, starting around 2000, is that Wall Street eliminated all
those safeguards, and hired Ph.D. physicists to come up with messy,
complicated arguments that it was still as safe as it used to be.
(Arguments which happened, in the event, to involve packaging up the
loans into pools, structuring the payouts from the pools in all sorts
of arcane ways, and arguing that it was the structure that
was now making it safe --- structures so complex
that almost no one really understands what they are.)

It seems they were wrong.

And the depressing thing is that it was all predictable. And, in
fact, predicted. And, in fact, the result of deliberate policy. As
the inimitable Daniel Davies explained in 2002,
before the game had halfway started:

... as far as we can tell, the American consumer is
basically only still spending because he thinks that magic [stock market] beans grown
on the Internet will pay for everything. ... And given that the stock market's been performing pretty
badly these days, and is beginning to appear on the cover of USA
today, lots of people are beginning to worry that the day of reckoning
might be at hand. Which would obviously, leave us in the shit.

This is the doctrine of the "wealth effect", and if you can dig up
a few factoids and linear regressions to illustrate it and avoid using
the word "shit", you can make a quite decent living as a pundit by
repeating the paragraph above. On the other hand, if you had been
placing bets on a US double-dip recession so far, you'd have lost
them, because Alan Greenspan and his merry gang at the Fed have a
solution to this problem. Basically, the solution's pretty simple and
it involves screwing interest rates down to the floor until mortgage
rates follow them down to Low Low Prices levels, and pointing out to
the Great American Consumer that it's "Bye-Bye, Magic Stock Market
Bubble Money!" but "Hello, Magic Housing Market Bubble
Money!". Marvellous.

Well, he wasn't all right. He left out the structured finance
part. But there's an important thing he got right here: the housing
bubble was the result of deliberate policy, on the part of the Federal
Reserve under Alan Greenspan --- Greenspan, who was also refusing to
use the authority Congress had given him to regulate non-bank mortgage
lenders, and was instead personally touting risky, safeguard-free new
mortgage products to get new, insecure buyers into the housing
market.

The result of which, among other things, is all those new suburbs
of Las Vegas and the Californian "inland empire" which are incomplete,
and falling to pieces even as the few residents get dispossessed.
It's not just a financial problem. It's an immense waste of social
resources --- money that could have gone into funding green
technology, instead spent on enormously wasteful, doomed projects
justified by high-flown rhetoric (let's boost home ownership to
promote responsibility!) that had gotten completely unmoored from
reality.

And with that in mind --- what was wrong with Communist central
planning? Well, precisely that it used high-flown rhetoric to justify
ill-conceived projects which might have been justified by lofty goals,
but which ultimately just didn't work. And that's what the capitalist
system seems to be giving us --- Greenspan, acting on his own, gave us
the bubble.

Now, we could say that this was still another government program.
But consider. The Fed isn't technically part of the government. It
is nominally owned, instead, by the member banks. And while its
management is appointed by Congress, it seems nevertheless to have
been acting, in this case, pretty much as the shareholders would have
wanted --- most of them were very active in the new, high-tech markets
for subprime mortgages and their even shadier derivatives (in effect,
the sheen on Greenspan's bubble), and all of
them are suffering for it now. So, if we took government out of the
Fed, and made it exactly what it appears to be nominally --- a
corporation responsible to its shareholders --- it almost certainly
wouldn't have done anything different. Particularly not if Greenspan
was still running it.

Which ought, perhaps, to give pause to partisans of the "wisdom of
the market", or "the wisdom of crowds"...

17 Comments:

Anonymous said...

Not to mention that many of those recent and superfluous suburbs built in California were built on top of some of the best agricultural land in the world, at the same time that food prices were skyrocketing worldwide. Basically, what we have seen is a fundamental lack of long term vision or planning.

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